More Bailout Fallout: Non-buyer’s Remorse

An interesting story in the WSJ Online today about American International Group (AIG)’s use of a standard tax write-off and the political firestorm it is creating…all because the Washington establishment thought it could hide behind semantics during the bailout era.

The benefits at issue were accrued by AIG as it amassed record losses amid the financial crisis; the U.S. tax code allows businesses to “carry forward” such net operating losses to offset future tax obligations, in effect saving on future tax bills. But those carry-forwards can vanish if a company is taken over or sold, an exception that prevents healthy companies from avoiding taxes by buying firms with significant losses.

The criticism from the former members of the congressional panel stems from a series of Treasury determinations beginning in late 2008 that said the federal government’s bailout of AIG, General Motors Co. and other firms didn’t constitute a sale.

The US government acquired as much as 90% ownership in AIG during the bailout era. Under most any definition, such a shift would be considered a change in corporate control. However, because the Treasury Dept. wanted to maintain the illusion that government was not taking over large swaths of the US economy, it pronounced that these bailouts were not what any student of financial markets understood them to be: an exchange of equity control and strings on management for access to cash. In short, a sale of control.

Now the Treasury Department’s ruling is coming back to bite. Under the US tax code, AIG and its investors have a legal right to carry forward losses from the financial crisis to offset taxable earnings now. But now legal-scholar-turned-bureaucrat-turned-politician Elizabeth Warren, and others, want to change the rules after the fact. Warren is calling on Congress to “end this special tax break”. I’m not sure what exactly is so “special” about this tax break, since it applies to any business, not just those bailed out by the Feds. So is Warren suggesting all businesses should be prohibited from carrying forward losses? Or only businesses whose losses the Federal government wasn’t willing to tolerate in the first place? After all, if the Treasury had let nature take its course, AIG (and many other bailout recipients who are now wondering about their own ability to carry forward losses) would have been bought–albeit likely in pieces–and this whole issue would be moot.

What’s really interesting about this whole argument is that Treasury still holds 70%–a controlling interest–of AIG’s stock. AIG reported their beneficial tax breaks weeks ago. Presumably Treasury is paying attention to their investments and knew about that decision, possibly even before it was publicly released. So why didn’t they exercise their controlling interest and stop management from electing to use the carry forward? More importantly, Treasury is the “owner” that stands to gain the most from this tax benefit. So what exactly is Ms. Warren and others complaining about?

Either way, this is a mess of Treasury’s own making with its semantic gamesmanship on whether the bailout should be named for the government take-over that it was. Seems like we have a bit of non-buyer’s remorse.